Thursday, January 19, 2006

Market Expectations for 2006

I'm not a professional economist , although I have studied economics, both micro and macro, extensively. As an equity portfolio manager, however, I believe I need to have some sense of what may affect the US equity markets in the coming year. Here is my current “back of the envelope” forecast for the coming year's equity market.

From what I have read, I expect US economic growth will continue to be decent for at least the first few months of 2006- perhaps through June. Estimates seem to indicate a range of 2.5-3%. Maybe less than prior years, but still decent. I don't think energy prices will unreasonably curtail this growth rate.

However, I suspect that by June, the prospect of the Iranian mullah-bomb will begin to affect investor psychology and dampen growth expectations. Fears of destabilized trade, a nuclear-fallout-tainted eastern Mediterranean and southern Europe, may cause market wobbles.

This will become a major drum beat for the mid-term US Congressional and scattered state gubernatorial elections. what to do about Iran? Is it another Iraq in the making? Is that a good or a bad thing? It’s probably a good thing, if you liked the way George Bush defused the outlaw menace that was Iraq under Saddam Hussein. It’s a bad thing if you like Al Gore.

The worst case would be a two-year drift of a weakened Rebublican-controlled House and Senate majority, or maybe even the outright loss of the House, coupled with the increasingly-lamer-duck status of President Bush. This latter development of a split in Congressional control between a Republican Senate and a Democratic House could mark the return of semi-gridlock. Only this time, rather than be a check on the liberal agenda of Bill Clinton, it could be a brake on important foreign policy action.

It is useful to remember that Iraq tried to play with nukes by starting almost from scratch. We know Iran actually has the material, facilities and people to do this. It’s a very different and far more explicit, verified threat this time.

The silver lining may be this. Iran hates Israel and is sworn to destroy it. Israel has the implicit backing of the Democratic party, and the Democrats in particular will not want to see Israel attacked and/or destroyed by an Iranian nuclear weapon. They may surprisingly decide to back George Bush on military action to remove the Iranian nuclear threat.

If I am remotely close in my conjectures, it probably spells another anemic year for US equity markets. Uncertainty, particularly concerning global conflict, tends to have that effect. I hope I’m wrong. Or, if I am right, that the threat is dispatched quickly and cleanly, leaving the markets to rise in subsequent appreciation.

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